Recent signs of consolidation among Indian credit rating agencies, with market leader CRISIL acquiring an 8.9 per cent stake in rival CARE, appear to have prompted SEBI to moot a new set of regulations to improve the governance and regulatory framework for the sector through a discussion paper. But while debate on the subject is welcome, the measures proposed offer an incomplete solution to the problems of conflict of interest, concentration and rating shopping by issuers that besiege this business worldwide.

There are two key aspects to SEBI’s proposals. One, in a bid to ensure the independence of ratings, SEBI proposes to restrict domestic rating agencies from acquiring more than 10 per cent of voting rights in any rival. The regulator’s concern that cross-holdings may lead to less divergence in rating views is valid. But the 10 per cent ownership cap seems to be a halfway measure. This threshold may deter consolidation between weaker players even while allowing existing players to gain some influence. A better way to ensure independence and diversity of rating views would be to encourage more competition in the sector. But SEBI’s second set of proposals seem to militate against this objective. To ensure that rating agencies have “adequate financial capabilities to invest in intellectual capital”, the regulator moots a tenfold increase in their minimum networth requirement to ₹50 crore and a five-year track record for the promoter in financial services. While the track record requirement is fine, the increase in minimum networth needs to be carefully thought through. High capital adequacy is critical to ensure the stability of financial institutions engaged in fund-based activities such as banks. But it has proved to be of limited utility in ensuring quality players in fee-based activities that rely on knowledge capital. In the mutual fund industry where SEBI had raised the networth norms a few years ago, they have proved anti-competitive. The ratings business in India is already quite concentrated with the top three players holding over three-fourths of the market. An oligopoly may not be desirable to ensure a fair deal to issuers, a better quality of ratings or accountability to end-users. The application of “fit and proper” criteria to the key shareholders in rating agencies may work better to ensure good governance.

What is really required to resolve the basic conflict that undermines the independence of rating agencies and leads to shopping by issuers is a brand-new revenue model for the sector that doesn’t require issuers to bear the rating fee. After being tripped up by ratings in the credit crisis, global regulators have been examining subscriber-pay models, the random assignment of rating mandates by a central agency and other ideas. SEBI should probably join this debate to find better solutions to the knotty problem of policing the raters.